European banks set to reduce their reliance on public sector funding further
The key chart
Trends in monthly flows (EUR bn) of bank issuance of debt securities (Source: ECB; CMMP)
Happier times ahead for FIG DCM bankers as European banks reduce their reliance on public sector sources of funding…
So what is happening?
European banks’ reliance on public sector sources of funding is falling as TLTRO funds reach maturity. Banks plan to issue more debt to (1) compensate for the expected decline in central bank funding and (2) to comply with minimum requirements for own funds and eligible liabilities (MREL).
What does the data say?
From the latest ECB “Monetary developments in the euro area, July 2023” release we can see positive monthly flows of debt securities with a maturity of over twelve month (counterparts to M3) in every month since October 2022. Cumulative 12-month flows turning positive in December 2022 and reached €198bn in the 12 months to July 2023, their highest level since October 2007 (see chart above).
Happier times for FIG DCM bankers…
The increasingly “commoditised” FIG DCM space can be a rather soulless place for issuers and bankers alike (in my experience). The good news is that issuance is recovering and is expected to remain positive in 2023-24 (see also the European Bank Authority’s annual funding plans report, July 2023). Happier times….
The impact of ECB policy on financing flows to the private sector
The key chart
Trends in cumulative monthly flows (12 months, EUR bn) of loans to the EA private sector (Source: ECB; CMMP)
The key message
Financing flows to the euro area (EA) private sector are slowing very sharply. This is unsurprising given the relatively rapid pass through of ECB policy to the cost of borrowing for EA corporates (NFCs) and, to a lesser extent, the cost of borrowing for EA households (HHs). Note that the composite cost of borrowing for NFCs has risen 2.96ppt in the twelve months since June 2022. This compares with a 2.12ppt increases over the whole 32 month, 2005-08 tightening period.
The risk here is that the ECB lacks a playbook for the most aggressive period of monetary tightening in its history. The rapid pace of adjustment in financing flows (see key chart above) suggests that the risk of policy errors are rising rapidly with negative, potential impacts on financing flows to the EA economy and to the region’s future growth prospects. Note again, that in aggregate, NFCs have already paid back loans in seven of the past nine months. The issue here is that the EA relies heavily on bank finance and the region needs more, not less, productive lending and investment.
The warning signs are clear. How will the “data dependent” ECB respond in September?
Flowing over a cliff edge
Trends in 12-month cumulative flows of credit to the private sector (EUR bn) (Source: ECB; CMMP)
Financing flows to the euro area (EA) private sector are slowing sharply. Cumulative monthly flows of credit to the private sector totalled €197bn in the 12 months to July 2023 down from €758bn in the 12 months to July 2022 (see chart above).
Changes in composite costs of borrowing (ppt) in months after start of policy tightening (Source: ECB; CMMP)
The slowdown in financing flows is unsurprising given the relatively rapid pass through of ECB policy tightening to the cost of borrowing (COB) for NFCs and, to a lesser extent, HHs (see chart above).
The composite COB for NFCs has risen 2.96ppt in the twelve months since June 2022. This compares with a 2.12ppt increases over the 32 month, 2005-08 tightening period. The composite COB for HHs has risen 1.73ppt in the twelve months since June 2022. Again, for context, this compares with a 1.79ppt increase over the longer 32 month, 2005-08 tightening period.
The risk here is that the ECB lacks a playbook for the most aggressive period of monetary tightening in its history.
Trends in monthly and cumulative 12m flows of lending to NFCs (EUR bn) (Source: ECB; CMMP)
In aggregate, NFCs have repaid loans in six of the past nine months (see chart above). Cumulative monthly flows have fallen from €390bn in the 12 months to October 2022 to only €85bn in the 12 months to July 2023.
Trends in monthly and cumulative 12m flows of lending to HHs (EUR bn) (Source: ECB; CMMP)
In aggregate, HHs have repaid loans in two of the past three months (in each case, mortgage loans). Cumulative monthly flows have fallen from €285bn in the 12 months to June 2022 to only €40bn in the 12 months to July 2023.
Trends in cumulative monthly flows of loans to HHs, mortgages and consumer credit (EUR bn) (Source: ECB; CMMP)
The rapid slowdown in monthly flows to HHs, reflects mortgage dynamics primarily (see chart above). The composite cost of mortgages has risen 1.73ppt since June 2022. Cumulative flows have fallen from €268bn in the 12 months to August 2021 to only €40bn in the 12 months to July 2023. Despite a 1.85ppt in the composite cost of consumer credit, monthly flows have remained relatively resilient. However, as described in early posts, the demand for consumer credit has lagged well below pre-pandemic levels.
Conclusion
In summary, the rapid pace of adjustment in financing flows described above suggests that the risk of policy errors are rising rapidly with negative, potential impacts on financing flows to the EA economy and to the region’s future growth prospects. The EA relies heavily on bank finance and the region needs more, not less, productive lending and investment.
The warning signs are clear. How will the “data dependent” ECB respond in September?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
The impact of ECB policy seen through 12-month cumulative flows
The key chart
12-month cumulative financing flows (EUR bn) presented in stylised consolidated balance sheet format (Source: ECB; CMMP)
The key message
Monetary developments in the euro area (EA) highlight the elevated risks of ECB policy errors and their potential, negative impact on financing flows to the EA economy.
Headline YoY growth numbers for broad money and its key component (narrow money) and counterpart (private sector credit) highlight the speed at which EA money and credit cycles are rolling over.
Broad money (M3) fell -0.4% YoY, the first annual decline since May 2010. Narrow money (M1) fell -9.2% YoY, driven by a 10.5% YoY decline in overnight deposits. Growth in private sector credit slowed to 1.6% YoY, the slowest annual rate of growth since May 2016. The warning signs are there…
Within broad money, arbitrage continues in favour of the highest remunerated deposits – depositors are actively seeking higher returns – but this is insufficient to compensate for outflows from overnight deposits. The very slow/limited pass through from higher policy rates to the cost of overnight deposits has been one of the unique features of the current hiking cycle.
Financing flows to the private sector, largely in the form of loans, remain positive in absolute terms. They are slowing very sharply on a cumulative 12-month basis, however (see next post for details).
In short, cumulative financing flows to the EA economy were -€96bn in the 12-months to July 2023, compared with flows of €1,574bn, €1,014bn and €92bn in the 12-months to July 2020, July 2021 and July 2022 respectively.
The risks of significant policy errors are rising with negative implications for financing flows to the EA economy. How will the “data-dependent” ECB respond in September?
The impact of ECB policy on financing flows to the EA economy
Headline YoY growth numbers for broad money and its key component (narrow money) and counterpart (private sector credit) highlight the speed at which EA money and credit cycles are rolling over (see chart below).
Growth rates (% YoY) in M3, M1 and PS credit (Source: ECB; CMMP)
Broad money (M3) fell -0.4% YoY, the first annual decline since May 2010. The outstanding stock of money (€15,957bn) has fallen -1.6% from its September 2022 peak (€16,214bn). Narrow money, the key component of broad money, fell -9.2% YoY, driven by a 10.5% YoY decline in overnight deposits. Growth in private sector credit, the key counterpart to broad money, slowed to 1.6% YoY, its slowest annual rate of growth since May 2016.
Recall that monetary aggregates are derived from the consolidated balance sheet of MFIs. The key components are found on the liabilities side of the balance sheet – narrow money (M1) which comprises currency in circulation, other short-term deposits (M2-M1) and marketable instruments (M3-M2). Note that longer-term liabilities are not part of M3 as they are regarded more as portfolio instrument than as a means of carrying out transactions. The key chart above presents 12-month cumulative flows in the form of a stylised consolidated balance sheet.
Growth rates (% YoY) in M1 and M2-M1 (Source: ECB; CMMP)
Within broad money, arbitrage continues in favour of the highest remunerated deposits but this is insufficient to compensate for outflows from overnight deposits. The annual growth rate in other short-term deposits (M2-M1) was 24% YoY in June and July 2023, the highest rate of growth since the start of the EMU. In contrast, the -9.2% YoY decline in narrow money was the sharpest contraction since the start of EMU (see chart above).
Monthly flows (EUR bn) in EA monetary aggregates (Source: ECB; CMMP)
The EA banking system has seen eleven consecutive months of outflows in overnight deposits (see chart above). The outflow of narrow money totalled -€1,072bn (see key chart above), overshadowing the positive inflows of €852bn and €153bn into other short-term deposits (M2-M1) and marketable securities (M3-M2) and, outside broad money, the €262bn inflow into longer-term financial liabilities (mainly debt securities issued by banks).
Note that the very slow/limited pass through from higher policy rates to the cost of overnight deposits has been one of the unique features of the current hiking cycle.
Trend in 12-month cumulative monthly flows of loans to the private sector (Source: ECB; CMMP)
Financing flows to the private sector, largely in the form of loans, remain positive in absolute terms. They are slowing sharply on a cumulative 12-month basis, however (see chart above and next post for details).
12-month cumulative financing flows (EUR bn) presented in stylised consolidated balance sheet format (Source: ECB; CMMP)
In short, cumulative financing flows were -€96bn in the 12-months to July 2023, compared with flows of €1,576bn, €1,014bn and €92bn in the 12-months to July 2020, July 2021 and July 2022 respectively.
The risks of significant policy errors are rising. How will a data-dependent ECB respond in September?
Please note that the summary charts and comments above are abstracts from more detailed analysis that is available separately.
Quarterly consumer credit flows expressed as a multiple of pre-pandemic average flows (Source: FRED; BoE; CMMP)
The key message
In May 2023, I asked, “have US and UK consumers read the recession script?” I noted that, “despite rising borrowing costs, quarterly consumer credit flows in 1Q23 remained above pre-pandemic levels. Fast-forward another quarter and the question remains largely the same – when will US and UK consumers read the recession script?
Contrasting consumer credit dynamics suggests divergent growth outlooks for investors and different challenges for the Federal Reserve, the Bank of England and the ECB.
US consumer credit demand has moderated from its elevated 2022 levels, but remains above pre-pandemic average levels. UK consumer credit demand remains surprisingly resilient, and above pre-pandemic levels too. Chair Powell and Governor Bailey face similar challenges as consumers continue to borrow to support consumption despite rising borrowing costs.
The contrast with consumer credit dynamics in the euro area (EA) is sharp. EA consumer credit demand remains subdued and well below pre-pandemic levels. President Lagarde faces a very different balancing act between weaker growth/recession and lower inflation.
In short, the messages from the US, UK and EA money sectors remind us that the risks of policy errors remain elevated in all three regions but for contrasting reasons…
When will US and UK consumers read the recession script?
Quarterly US consumer credit flows (Source: FRED; CMMP)
US consumer credit demand is moderating sharply but remains above pre-pandemic levels. Quarterly flows of consumer credit have fallen from $87bn in 4Q22 to $52bn in 1Q23 and $50bn in 2Q23, but remain above their pre-pandemic level of €45bn (see chart above).
Monthly US consumer credit flows (Source: FRED; CMMP)
The monthly flow of US consumer credit was more volatile during the 2Q23 (see chart above). Flows ranged from $22.3bn (1.5x pre-pandemic average) in April 2023 to only $9.5bn (0.6x pre-pandemic average) in May 2023 and then $17.8bn (1.2x pre-pandemic flow) in June 2023.
Quarterly UK consumer credit flows (Source: BoE; CMMP)
UK consumer credit demand remains surprisingly resilient. Quarterly flows increased from £3.1bn in 4Q22 to £4.5bn in 1Q23 and £4.3bn in 2Q23. These flows were 0.9x, 1.2x and 1.2x the pre-pandemic average quarterly flow of £3.6bn (see chart above).
Monthly UK consumer credit flows (Source: BoE; CMMP)
Monthly flows during the 2Q23 were £1.6bn, £1.1bn and £1.7bn in April, May and June 2023 respectively. These flows were 1.6x, 1.1x and 1.7x the pre-pandemic average flows respectively. (see chart above).
Quarterly EA consumer credit flows (Source: ECB; CMMP)
Euro area consumer credit demand remains consistently subdued, in sharp contrast to trends observed in both the US and the UK. Quarterly flows have fallen from €5.2bn in 4Q22 to €4.2bn in 1Q23 and €3.4bn in 2Q23, the lowest quarterly flow since 2Q21 (see chart above). Quarterly flows have failed to recover to their pre-pandemic level of €10.3bn.
Monthly EA consumer credit flows (Source: ECB; CMMP)
Monthly flows have also declined during the quarter from €2.0bn in April to €1.3bn in May to only €23m in June 2023 (see chart above). As noted in previous posts, the fact that demand for consumer credit remains very subdued in absolute terms and in relation to trends observed in the US and the UK makes the ECB’s tasks slightly easier (while elevating policy risks at the same time).
Conclusion
Contrasting consumer credit dynamics suggests divergent growth outlooks for investors and different challenges for the Federal Reserve, the Bank of England and the ECB.
Demand is moderating sharply in the US but remains resilient and above the levels seen pre-pandemic, at least so far. UK demand also remains surprisingly resilient and above pre-pandemic levels, at least for the time being (and as suggested by OBR forecasts). Chair Powell and Governor Bailey face similar challenges as consumers continue to borrow to support consumptions despite rising borrowing costs.
In contrast, the message from the money sector for EA growth is much weaker and presents President Lagarde with a very different balancing act between weaker growth/recession and lower inflation.
The risks of policy errors remain elevated in all three regions but for contrasting reasons…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
